The Downside Of Lower Oil Prices In The U.S.

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by: Kevin Mahn

Brent Crude oil, arguably the most recognized global benchmark of oil prices, is currently trading at under $70 a barrel and there is a growing likelihood that it could trade lower, or remain near these price levels for some period of time. With worldwide demand for oil remaining weak and some of the world's largest producers of oil continuing to pump oil at, or even above, their existing production levels, the supply/demand equation seems to be pointing towards lower oil prices as opposed to higher oil prices. The Organization of Petroleum Exporting Countries (OPEC) did not help matters in this regard by taking no immediate action to force a reduction in the worldwide supply of crude oil at its most recent meeting on November 27.

End of Day Commodity Futures Price Quotes for Crude Oil Brent

Source: NASDAQ, December 1, 2014. Timeframe of price history is June 2014 - December 2014. Past performance is not an indication of future results.

While lower energy costs in the U.S. may help increase consumer sentiment and spur consumer spending as consumers have more discretionary dollars to spend as we approach the always important holiday shopping season, there is also a potential downside to cheaper oil prices within the U.S. as well. To appreciate this perspective, one needs to recognize that the U.S. is becoming more energy independent. Looking ahead, we believe that there is a growing likelihood that the U.S. will become a net energy; oil and natural gas, exporting country over the course of the next decade. We are not alone in this viewpoint as others seem to also be optimistic about the U.S. achieving energy independence in the not so distant future. For example, according to a MarketWatch article entitled, "North America energy independent by 2020, but still tied to markets", consultant Wood Mackenzie predicted that North America will become a net energy exporter by 2020. Certainly there are a variety of factors which could cause this viewpoint and these forecasts/predictions to not be realized.

In order to achieve this level of energy independence, the U.S. continues to invest in terms of technology, equipment and human capital, significantly in our own energy infrastructure capabilities. This increased investment translates to a growing proportion of our country's Gross Domestic Product (GDP) within the Energy sector. The current oil production boom in the U.S., which is helping the U.S. to surpass both Saudi Arabia and Russia as the world's top oil producer, has been powered in large part by horizontal drilling and hydraulic fracturing (a.k.a. "fracking") for shale oil and gas related projects. The picture below will help to describe the controversial fracking process a little further.

Source: UC Santa Barbara Geography/News & Events/Department News, "Supply Shock from North America Oil Rippling through Global Markets", May 2013

Some of this investment may slow down if oil prices stay at low levels. For example, sustained low prices could halt some drilling projects, postpone others, squeeze certain fracking operations and even lead to the loss of certain jobs within the energy sector. While lower fuel prices would not be enough to offset the elimination of income for those workers in the energy industry that may be laid off following this type of scenario, they would certainly still benefit others with jobs not directly associated with the energy sector and help propel GDP upward over the short term seeing as consumer spending still accounts for approximately 70% of GDP.

While this may come as a surprise to some, the net long term effect could actually become somewhat of a drag on U.S. GDP if oil prices drop further and/or remain at those lower prices for an extended period of time.